On March 5, 2014, the U.S. Supreme Court (“the Court”) will hear arguments in a case that has the potential to severely limit an investor’s ability to bring class action securities claims. Halliburton v. Erica P. Johns Fund seeks to reexamine the “fraud-on-the-market” presumption of reliance established in Basic Inc. v. Levinson, decided in 1988. To establish a prima facie case of securities fraud, a plaintiff needs to allege that the defendant knowingly or recklessly misrepresented a material fact that the plaintiff relied on, which caused the plaintiff’s loss. In Basic, however, the Supreme Court established the fraud-on-the-market presumption, which allows a plaintiff to prove reliance by merely demonstrating that the stock was traded publicly and in an efficient market. This presumption, therefore, saves the plaintiff from having to prove that she relied on a specific misrepresentation by the defendant. The theory underlying the presumption stems from the assumption that an efficient market reflects all investor-relevant information pertaining to its publicly traded companies. Without this presumption, class certification would be highly unlikely because class plaintiffs would need to allege that every member of the class relied on specific misrepresentations of the sellers.
Since Basic in 1988, the Court has taken steps to limit the classes that can bring suit under SEC Rule 10(b)-5 for securities fraud; for example, in Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc, the Court held that “secondary actors” to fraud, such as aiders and abettors, could not be subjected to class action suits under 10(b)-5. Also, in Morrison v. National Australia Bank Ltd., the Court held that U.S. securities laws did not apply to international purchases, thereby eliminating a large source of securities fraud class actions. In each of these cases, however, the Court declined to overrule the underlying presumption founded in Basic. This pattern of decisions coupled with the grant of certiorari for Halliburton suggests that the Court may be ready to overrule Basic and effectively eliminate class action securities fraud cases. Aside from other potential future implications, this decision and the mere possibility of the Court overruling Basic is likely to have serious negative effects on the settlement value of pending class action securities claims.
Overruling Basic entirely is not the only resolution available to the Supreme Court, however. The Court may choose simply to narrow its previous holding and modify the test used for class certification for 10(b)-5 claims. There are two viable options for this change. The first involves a multi-factor analysis as to whether trades actually occurred in an efficient market. This test, which was set forth in Cammer v. Bloom, considers whether a market was efficient by considering the weekly trading volume of the stock, the number of analysts following the stock, the extent market makers traded the stock, the issuer’s eligibility to file certain SEC registration forms, and the demonstration of cause-and-effect between material disclosures and changes to the stock’s price. The test logically follows from the fraud-on-the-market presumption by still requiring a showing of an efficient market, but the test places a higher burden on potential litigants by requiring that they show that the defendant’s stock was traded on such a market. An alternative to a multi-factor analysis would be for the Court to adopt the Third Circuit’s approach, which allows the defendant to rebut the presumption at the class-certification stage by showing that the alleged misrepresentations did not have an effect on the stock’s market price. Regardless of the specific outcome, recent trends in case law show that the Court is likely to make significant alterations to the Basic presumption, making class litigation more difficult for investors alleging fraud.
Posted March 2, 2014